ATB Arlington Tankers Ltd

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K/A

(Amendment No. 1)

 

ANNUAL REPORT

PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 001-32343

 

Arlington Tankers Ltd.

(Exact name of Registrant as specified in its charter)

 

Bermuda

(Jurisdiction of incorporation or organization)

 

First Floor, The Hayward Building

22 Bermudiana Road

Hamilton HM 11, Bermuda

(Address of principal executive offices)

 

Registrant’s telephone number, including area code:

(441) 292-4456

 

Securities registered pursuant to Section 12(b) of the Act.

 

 

Securities registered pursuant to Section 12(g) of the Act.
None
(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  o      No  þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  o      No  þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o      No  þ

 

The aggregate market value of the registrant’s common shares held by non-affiliates of the registrant as of June 29, 2007, was approximately $364,586,700 based on the closing price of $28.68 per share for the registrant’s common shares as reported on the New York Stock Exchange on that date.

 

As of February 28, 2008, the registrant had 15,500,000 common shares issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Specified portions of the registrant’s proxy statement for the registrant’s 2008 Annual General Meeting of Shareholders to be held on July 17, 2008, which are expected to be filed pursuant to Regulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2007, are incorporated by reference into Part III of this report.

 

 

TABLE OF CONTENTS

 

 

 

In this Annual Report on Form 10-K, references to “we,” “our,” “us” and the “company” refer to Arlington Tankers Ltd. and, as the context requires, our subsidiaries.

EXPLANATORY NOTE

     The Registrant is filing this Amendment No. 1 to its Annual Report on Form 10-K for the year ended December 31, 2007, as originally filed with the SEC on March 14, 2008, for the purpose of revising Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in response to a comment letter from the SEC. This Amendment No. 1 does not reflect the restatement of any previously reported financial statements or, except as noted above, change any other disclosures.

     This Amendment No. 1 continues to speak as of the date of the original Form 10-K for the year ended December 31, 2007 and the Registrant has not updated or amended the disclosures contained herein to reflect events that have occurred since the filing of the original Form 10-K, or modified or updated those disclosures in any way other than as described in the preceding paragraph. Accordingly, this Amendment No. 1 should be read in conjunction with the Registrant’s filings made with the SEC subsequent to the filing of the original Form 10-K on March 14, 2008.

 

PART I

 

ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements, and the related notes, and the other financial and other information included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based on assumptions about our future business. Our actual results will likely differ from those contained in the forward-looking statements and such differences may be material. This Annual Report on Form 10-K contains certain forward-looking statements and information relating to us that are based on beliefs of our management as well as assumptions made by us and information currently available to us, in particular in this “Item 7. Management’s Discussions and Analysis of Financial Condition and Results of Operations.” When used in this document, words such as “believe,” “intend,” “anticipate,” “estimate,” “project,” “forecast,” “plan,” “potential,” “will,” “may,” “should,” and “expect” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. All statements in this document that are not statements of historical fact are forward-looking statements. Forward-looking statements include, but are not limited to, such matters as:

 

 

Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Many factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, the factors described in Part I, Item 1A below under the heading “Risk Factors” and the factors otherwise referenced in this report. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in the forward-looking statements included herein. We do not intend, and do not assume any obligation, to update these forward-looking statements.

 

Overview

 

We are an international seaborne transporter of crude oil and petroleum products. We were incorporated in September 2004 under the laws of Bermuda. We were originally a jointly owned subsidiary of Stena AB (publ), or Stena, and Concordia Maritime AB (publ), or Concordia.

 

In November 2004, we completed our initial public offering and acquired our six Initial Vessels, consisting of two V-MAX tankers, two Panamax tankers and two Product tankers. The total purchase price for the Initial Vessels equaled approximately $426.5 million, consisting of $345.5 million in cash and 4,050,000 common shares that we issued to subsidiaries of Concordia and Stena and two companies owned jointly by Stena and Fram. We financed the cash portion of the purchase price through our initial public offering and borrowings under a secured credit facility. The 4,050,000 shares issued to the sellers were valued at $81 million, based on the initial public offering price of $20.00 per share. An aggregate of 1,717,500 of the shares issued to the vessel sellers were sold in our initial public offering in connection with the underwriters’ exercise of their over-allotment option. We did not receive any proceeds from the sale of these shares.

Effective November 10, 2004, we chartered our six Initial Vessels to subsidiaries of Stena and Concordia under fixed rate charters. Under the charters, we receive fixed Basic Hire in amounts that increase annually at a rate equal to the annual increase in the fees payable under our ship management agreements described below. Furthermore, in addition to the fixed rate Basic Hire, each of our Initial Vessels has the possibility of receiving Additional Hire from the Charterers through profit sharing arrangements related to the performance of the tanker markets on specified geographic routes, or from actual time charter rates. Additional Hire is not guaranteed, except for the Additional Hire related to the Sun International sub-charters, and correlates to weighted average historical voyage rates for the specified routes. The charters contain options on the part of the Charterers to extend the terms of the charters. Stena and Concordia have each agreed to guarantee the obligations of their respective subsidiaries under the charters.

 

Effective November 10, 2004, we have also entered into ship management agreements with Northern Marine. The ship management agreements provide for the technical management of our Vessels. Under the ship management agreements, we have agreed to pay Northern Marine a flat fee per day per Vessel, which increases 5% every year.

 

As a result of our entering into the Charters, our revenues since November 2004 have been generated from charter payments made to us by the Charterers. As a result of our entering into the ship management agreements, our Vessel operating expenses for the Vessels are fixed, increasing 5% annually. These arrangements are designed to provide us with stable and generally predictable cash flow and reduce our exposure to volatility in the spot markets for the Vessels.

 

On December 12, 2005, we entered into a five-year credit agreement with The Royal Bank of Scotland plc. The credit agreement provides for a credit facility of up to $229.5 million. The purpose of the credit agreement was to (1) refinance the indebtedness under our $135 million debt facility with a group of banks for which Fortis Bank (Nederland) N.V. acted as agent, (2) finance the purchase price of the two Additional Vessels from the subsidiaries of Stena and (3) general corporate purposes. We completed the refinancing of our previous debt facility in December 2005 and completed the Additional Vessel acquisition in January 2006. The credit agreement matures on January 5, 2011. All amounts outstanding under the credit agreement must be repaid on that maturity date. There is no principal amortization prior to maturity. Borrowings under the credit agreement bear interest at LIBOR plus a margin of 75 basis points. The margin would increase to 85 basis points if the ratio of the fair market value of our Vessels to the amount outstanding under the loan facility falls below 2.0. The increased interest margin is equivalent to approximately $229,500 per year in increased interest costs in the event the ratio falls below 2.0. In connection with the credit agreement, we entered into an interest rate swap agreement with The Royal Bank of Scotland. As a result of this swap, we effectively fixed the interest rate on the loan agreement at 5.7325%. The net annual cash interest costs will approximate 5.38% due to the cash benefit that we received in December 2005 from the termination of a swap with Fortis Bank of $4.8 million. That cash benefit has been designated by our Board of Directors to offset the higher interest costs over the life of the $229.5 million credit facility.

 

On January 5, 2006, we entered into a series of agreements with Stena Bulk, Northern Marine and Stena Maritime, which we refer to as the Stena Parties, pursuant to which we, through wholly owned subsidiaries, completed the purchase of the Additional Vessels from subsidiaries of Stena Maritime for a purchase price per Vessel of $46 million. In connection with the acquisition of the Additional Vessels from the Stena Parties we also entered into certain related agreements and amended certain of the agreements related to the Initial Vessels. At the closing of the acquisition, our subsidiaries that purchased the Additional Vessels and Stena Bulk entered into time charter parties. Under the time charter parties, which are substantially similar to the time charter parties that our subsidiaries have entered into for the Initial Vessels, our subsidiaries that purchased the Additional Vessels time chartered the Additional Vessels to Stena Bulk for an initial period of three years at the fixed daily Basic Hire. At the end of the initial three-year period, both we and Stena Bulk have the option to extend the time charters on a vessel-by-vessel basis for an additional 30 months, at the fixed daily Basic Hire. If Stena Bulk exercises this option, there will be an Additional Hire provision during the 30-month period. If we exercise this option, there will be no Additional Hire arrangement. Furthermore, if Stena Bulk exercises the 30-month option, there will be two additional one-year options, exercisable by Stena Bulk, at the fixed daily Basic Hire set forth below, but without an Additional Hire provision.

At the closing of the acquisition, the time charter parties for our existing Product tankers and Panamax tankers were amended. These amendments modified the charter periods for our previously acquired Product tankers and Panamax tankers and provided certain changes to the calculation of Additional Hire under these Time Charter Parties. The amendments to the terms of the Charters provided that (1) the five-year fixed term for one of the Product tankers ( Stena Consul ) and one of the Panamax tankers ( Stena Compatriot ) was extended to November 2010, followed by three one-year options exercisable by Stena Bulk and (2) the five-year fixed term for one of the Product tankers ( Stena Concord ) and one of the Panamax tankers ( Stena Companion ) was reduced to a November 2008 expiration date, followed by three one-year options exercisable by Stena Bulk. The term of the charters for the V-MAX tankers were not amended. The amendments to the Additional Hire provisions provided for certain favorable adjustments to fuel consumption metrics used in the calculation of Additional Hire for the Product tankers and Panamax tankers.

 

At the closing of the acquisition, the ship management agreements for our Initial Vessels were also amended. These amendments modified the provisions relating to drydocking of the Vessels. Specifically, the amendments provided that all drydockings during the term of the ship management agreements are to be at the sole cost and expense of Northern Marine. In addition, Northern Marine agreed to conduct at least one mid-period drydocking for each Product tanker and Panamax tanker prior to redelivery of such Vessels. Furthermore, upon redelivery of the Vessels to us at the expiration of the ship management agreements, Northern Marine has agreed to pay to us a drydocking provision for each day from the completion of the last special survey drydocking during the term of the applicable ship management agreement (or if no special survey occurs during the term of such agreement, from the date of commencement of such agreement), to date of redelivery at the daily rates specified in the ship management agreements.

 

Factors Affecting Our Results of Operations and Cash Available for Dividends

 

The principal factors that have affected our results of operations, financial position and cash available for dividends since November, 2004, and that we expect to affect our future results of operations, financial position and cash available for dividends include:

 

 

We derive our revenues from our long term fixed rate time charters with the Charterers. Our Vessels are time chartered to the Charterers under the Charters. Under a time charter, the charterer pays substantially all of the voyage expenses, but the vessel owner pays the vessel operating expenses. In the case of a spot market charter, the vessel owner pays both the voyage expenses and the vessel operating expenses. Vessel operating expenses are the direct costs associated with running a vessel and include crew costs, vessel supplies, repairs and maintenance, drydockings, lubricating oils and insurance. Voyage expenses are fuel costs and port charges. See “Item 1. Business — Charter Arrangements” for more information regarding the charters.

Our ability to earn Additional Hire under our Charters will depend on whether the Charterers operate the Vessels under time charters or in the spot market and the relative freight rates in each market. We will continue to earn guaranteed Additional Hire under our V-MAX tanker Charters while those Vessels remain sub-chartered by subsidiaries of Concordia to Sun International. We also expect to earn Additional Hire from the sub-charters of our V-MAX tankers to subsidiaries of Litasco, so long as those Vessels are in service. With respect to our other Vessels, our ability to earn Additional Hire will depend on market conditions in the tanker industry, which has historically been highly cyclical, experiencing volatility in profitability, vessel values and freight rates. In particular, freight and charter rates are strongly influenced by the supply of tankers and the demand for oil transportation services. Our expenses consist primarily of fees under our ship management agreements, depreciation, administrative expenses and interest expense.

 

Our Vessel owning subsidiaries have entered into ship management agreements with Northern Marine under which Northern Marine is responsible for all technical management of the Vessels, including crewing, maintenance, repair, drydockings, Vessel taxes, insurance and other Vessel operating and voyage expenses. Under these agreements we pay a fixed daily fee for each Vessel which increases 5% annually. See “Item 1. Business — Ship Management Agreements” for more information regarding our ship management agreements.

 

Depreciation is the periodic cost charged to our income for the reduction in usefulness and long term value of our Vessels. No charge is made for depreciation of Vessels until they are delivered. We depreciate the cost of our Vessels less salvage value over 25 years on a straight-line basis. Including depreciation on the two new Product tankers that we purchased on January 5, 2006, we estimate that depreciation will be approximately $15.7 million per year.

 

Administrative expenses include salaries and other employee related costs, office rents, legal and professional fees and other general administrative expenses. Based on our current activities we estimate that our administrative expenses will be approximately $2.4 to $2.5 million in 2008.

 

Our interest expense prior to December 21, 2005 represented interest expense under our old credit facility. Subsequent to December 21, 2005, we began to incur interest expense under our $229.5 million credit facility, which matures in January 2011. By entering into an interest rate swap agreement, we effectively fixed the interest rate under the facility at approximately 5.7325% per year. In December 2005 as a result of terminating an interest rate swap and debt facility with a group of banks led by Fortis Bank N.V., we realized a net gain on the termination of the swap and debt facility of $4.055 million. The cash proceeds from the termination of the swap was $4.8 million. Our Board has designated the $4.8 million benefit from the Fortis swap as an offset to the interest costs of the secured credit facility. Accordingly, we estimate that interest expense under the secured credit facility will be approximately $13.3 million per year, and that approximately $1 million per year of interest expense will be offset by the benefit from the termination of the Fortis swap.

 

We anticipate that we will seek to refinance our secured credit facility at or prior to its maturity. There can be no assurance that we will be able to do so on acceptable terms. Interest rates may be higher than current rates at the time we seek to refinance our secured credit facility and the prevailing market terms for loans such as the type we would need to refinance our secured credit may require periodic payments to amortize the outstanding principal. Such higher rates, principal amortization requirements or other terms could prevent our ability to complete a refinancing or could adversely impact our future results, including the amount of cash available for future dividends. Please see “Item 1A. Risk Factors — We cannot assure you that we will pay any dividends,” “— If we cannot refinance our secured credit facility, or in the event of a default under the facility, we may have to sell our Vessels, which may leave no additional funds for distributions to shareholders” and “— We may not be able to recharter our Vessels profitably after they expire, unless they are extended at the option of the Charterers.”

 

The Charterers pay us Basic Hire monthly in advance and Additional Hire, if any, quarterly in arrears. We pay Northern Marine the ship management fees monthly in advance. We pay interest under our credit agreement quarterly in arrears.

 

Although inflation has had a moderate impact on our Vessel operating expenses and corporate overhead, our management does not consider inflation to be a significant risk in the current and foreseeable economic

environment. Because substantially all of our revenues and expenses are denominated in U.S. dollars, we do not expect foreign exchange fluctuations to have a significant effect on our future results of operations.

 

Critical Accounting Policies And Estimates

 

Our accounting policies are more fully described in Note 2 to the Notes to Condensed Consolidated Financial Statements included elsewhere in this report. As disclosed in Note 2 to the Notes to Consolidated Financial Statements, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic and industry conditions, present and expected conditions in the financial markets, and in some cases, the credit worthiness of counterparties to contracts. We regularly reevaluate these significant factors and make adjustments where facts and circumstances dictate. The following is a discussion of the accounting policies that we apply and that we consider to involve a higher degree of judgment in their application.

 

Revenue Recognition

 

Revenues are generated from time charters and the spot market. Charter revenues are earned over the term of the charter as the service is provided. Probable losses on voyages are provided for in full at the time such losses can be estimated.

 

Vessels, Depreciation and Impairment

 

Our Vessels represent our most significant assets and we state them at cost less accumulated depreciation. Depreciation of our Vessels is computed using the straight-line method over their estimated useful lives of 25 years. This is a common life expectancy applied in the shipping industry. Significant vessel improvement costs are capitalized as additions to the vessel rather than being expensed as a repair and maintenance activity. Should certain factors or circumstances cause us to revise our estimate of vessel service lives, depreciation expense could be materially lower or higher. If circumstances cause us to change our assumptions in making determinations as to whether vessel improvements should be capitalized, the amounts we expense each year as repairs and maintenance costs could increase, partially offset by a decrease in depreciation expense.

 

We review long-lived assets used in our business on an annual basis for impairment, or whenever events or changes in circumstances indicate that the carrying amount of an asset or a group of assets may not be recoverable. We assess recoverability of the carrying value of the asset by estimating the future net cash flows expected to result from the asset, including eventual disposition. If the future undiscounted net cash flows are less than the carrying value of the asset, an impairment loss is recorded equal to the difference between the asset’s carrying value and its fair value. We estimate fair value based on sales price negotiations, active markets, if available, and projected future cash flows discounted at a rate determined by management to be commensurate with our business risk. The estimation of fair value using these methods is subject to numerous uncertainties which require our significant judgment when making assumptions of revenues, operating costs, selling and administrative expenses, interest rates and general economic business conditions, among other factors.

 

Results of Operations

 

Year Ended December 31, 2007 Compared To Year Ended December 31, 2006

 

Total operating revenues, net

 

Total operating revenues were $70.2 million in 2007 compared to $69.4 million in 2006. The 2007 revenues consisted of $65.9 million in Basic Hire, $2.3 million in Additional Hire related to the V-MAX vessels and $2.0 million of Additional Hire revenues related to profit sharing arrangements for the other eligible vessels. The 2007 revenues were about the same as the 2006 revenues reflecting slightly higher Basic Higher revenues in 2007,

offset by slightly lower Additional Hire revenues. We expect that revenues related to Basic Hire and Additional Hire related to the V-MAX vessels will be slightly higher in 2008 at approximately $69.9 million.

 

The Vessels were effectively off-hire for a combined total of 40 days in each of 2007 and 2006. The off-hire amount of five days per vessel per annum is guaranteed through the management agreements with Northern Marine.

 

Total Vessel operating expenses

 

Total Vessel operating expenses were $20.0 million in 2007 compared to $18.6 million in 2006. The increase in Vessel operating expenses in 2007 reflects a 5% increase in the vessel management fees under the vessel management agreements with Northern Marine. We expect Vessel operating expenses to increase in 2008 to approximately $21.2 million principally due to the 5% annual contractual increase in vessel management fees to Northern Marine.

 

Depreciation

 

Depreciation was $15.6 million in 2007 and $16.1 million in 2006. The decrease in depreciation is attributed to a revision in the estimated salvage value for the Vessels in the fleet. We estimate that depreciation in 2008 will be approximately $15.8 million.

 

Administrative expenses

 

Administrative expenses were $2.5 million in 2007 compared to $2.7 million in 2006. The decrease in administrative expenses is primarily attributed to higher expenses incurred in 2006 in connection with our purchase of two additional vessels and legal and accounting fees related to the “universal shelf” Registration Statement on Form S-3 that we filed in November 2006. We estimate that administrative expenses for 2008 will be approximately $2.4 — $2.5 million.

 

Other expenses, net

 

Other expenses net represents interest expense, net of interest income and other financial items, including the unrealized gain or loss on the fair value of an interest rate swap for our $229.5 million secured credit facility. Other expenses, net were $20.4 million in 2007 compared to $10.6 million in 2006. The 2007 amount includes interest expense of $13.7 million and an unrealized loss of $7.5 million on the fair value of the interest rate swap on our $229.5 secured credit facility, offset by $828,000 of interest income. The increase in other expenses, net of $9.8 million over 2006 is entirely attributed to the change in fair value of an interest rate swap on our $229.5 million secured credit facility, which was an unrealized gain of $2.2 million in 2006 and an unrealized loss of $7.5 million in 2007.

 

With respect to our $229.5 secured credit facility, by entering into an interest rate swap agreement, we have effectively fixed the interest rate under the facility at 5.7325% for the five-year term. We estimate that interest expense under the facility will be approximately $13.3 million per year. Our Board of Directors has designated the $4.8 million cash benefit from the termination of interest rate swap to offset the interest costs under the secured credit facility. We expect to offset the higher interest costs each quarter through our cash dividend distribution of a pro rata portion of the $4.8 million (approximately $240,000 per quarter) benefit from the interest rate swap. As a result of the prorated benefit from the termination of the interest rate swap, we expect our cash interest costs per year to approximate $12.3 million. Because substantially all of our revenues and expenses are denominated in U.S. dollars, we do not expect foreign exchange fluctuations to have a significant effect on our future results of operations.

 

Year Ended December 31, 2006 Compared To Year Ended December 31, 2005

 

Total operating revenues, net

 

Total operating revenues were $69.4 million in 2006 compared to $55.5 million in 2005. The 2006 revenues consisted of $64.3 million in Basic Hire, $2.4 million in guaranteed Additional Hire related to the V-MAX vessels and $2.7 million of Additional Hire revenues related to profit sharing arrangements for other eligible Vessels. The 2006 revenues were higher than 2005 principally due to the purchase of the two Additional Vessels in January 2006.

The Vessels were effectively off-hire for a combined total of 40 days in 2006, which compares to 30 off-hire days in 2005. The off-hire amount of five days per vessel per annum is guaranteed through the management agreements with Northern Marine.

 

Total Vessel operating expenses

 

Total Vessel operating expenses were $18.6 million in 2006 compared to $14.0 million in 2005. The increase in Vessel operating expenses in 2006 reflects the additional costs associated with the two Additional Vessels purchased in January 2006 and a 5% increase in the vessel management fees for the Initial Vessels under the vessel management agreements with Northern Marine.

 

Depreciation

 

Depreciation was $16.1 million in 2006 and $12.4 million in 2005. The increase in depreciation is attributed to the addition of the two Additional Vessels purchased in January 2006.

 

Administrative expenses

 

Administrative expenses were $2.7 million in 2006 compared to $2.5 million in 2005. The increase in administrative expenses is primarily attributed to higher administrative fees related to the purchase of the two additional vessels in January 2006, legal and accounting fees related to the “universal shelf” Registration Statement on Form S-3 that we filed in November 2006 and higher compensation costs related to executive bonuses earned in 2006.

 

Other expenses, net

 

Other expenses net represents interest expense, net of interest income and other financial items, including the gain on the termination of an interest rate swap, as well as the unrealized loss on the fair value of an interest rate swap for our $229.5 million secured credit facility. Other expenses, net were $10.6 million in 2006 compared to $4.6 million in 2005. The 2006 amount includes interest expense of $13.6 million offset by $734,000 of interest income and an unrealized gain of $2.2 million of the fair value of an interest rate swap on our $229.5 secured credit facility. The increase in other expenses, net of $6.0 million over 2005 is attributed to $6.9 million in higher interest expense associated with our $229.5 million term secured credit facility offset by a net gain of $4.1 million realized in 2005 on the termination of the interest rate swap and debt facility with Fortis Bank N.V., an improvement of $2.2 million in the fair value of our interest rate swap, and a $500,000 increase in interest income.

 

Liquidity and Capital Resources

 

We operate in a capital intensive industry. Our liquidity requirements relate to our operating expenses, including payments under our ship management agreements, quarterly payments of interest and the payment of principal at maturity under our $229.5 million secured credit facility and maintaining cash reserves to provide for contingencies.

 

In December 2005, we entered into a five-year term loan agreement with The Royal Bank of Scotland. The term loan agreement provides for a facility of $229.5 million. The purpose of the term loan agreement was to (1) refinance our existing indebtedness, (2) finance the purchase price of two Product tankers from Stena and (3) general corporate purposes. We completed the refinancing of our indebtedness in December 2005 and completed the Additional Vessel acquisition in January 2006. The term loan agreement matures on January 5, 2011. All amounts outstanding under the term loan agreement must be repaid on that maturity date. There is no principal amortization prior to maturity. Borrowings under the term loan agreement bear interest at LIBOR plus a margin of 75 basis points. The margin would increase to 85 basis points if the ratio of the fair market value of the Company’s Vessels to the amount outstanding under the loan facility falls below 2.0, which we refer to as the Ratio. The increased interest margin is equivalent to approximately $229,500 per year in increased interest costs in the event the Ratio falls below 2.0. In connection with the term loan agreement, we have entered into an interest rate swap agreement with The Royal Bank of Scotland. As a result of this swap, we effectively fixed the interest rate on the term loan agreement at 5.7325%. The annual cash interest costs will approximate 5.38% due to the cash benefit

that we received in December 2005 from the $4.8 million termination of a prior swap. That cash benefit has been designated by the Board of Directors to offset the higher interest costs over the life of the $229.5 million credit facility. The term loan agreement provides that if at any time the aggregate market value of our Vessels that secure the obligations under the Loan Agreement is less than 125% of the loan amount, we must either provide additional security or prepay a portion of the loan to reinstate such percentage. The term loan agreement also contains financial covenants requiring that at the end of each financial quarter (1) our total assets (adjusted to give effect to the market value of the Vessels) less total liabilities is equal to or greater than 30% of such total assets and (2) we have positive working capital.

 

We had outstanding long term debt of $229.5 million as of December 31, 2007 and December 31, 2006. This amount reflects outstanding borrowings under our secured credit facility, which matures in January 2011. By entering into an interest rate swap agreement, we have effectively fixed the interest rate under the facility at approximately 5.7325% per year.

 

We anticipate that we will seek to refinance our secured credit facility at or prior to its maturity. There can be no assurance that we will be able to do so on acceptable terms. Interest rates may be higher than current rates at the time we seek to refinance our secured credit facility and the prevailing market terms for loans such as the type we would need to refinance our secured credit may require periodic payments to amortize the outstanding principal. Such higher rates, principal amortization requirements or other terms could prevent our ability to complete a refinancing or could adversely impact our future results, including the amount of cash available for future dividends. Please see “Item 1A. Risk Factors — We cannot assure you that we will pay any dividends,” “— If we cannot refinance our secured credit facility, or in the event of a default under the facility, we may have to sell our Vessels, which may leave no additional funds for distributions to shareholders” and “— We may not be able to recharter our Vessels profitably after they expire, unless they are extended at the option of the Charterers.”

 

As of December 31, 2007, we had cash, cash equivalents and short term investments of $18.8 million. Net cash provided by operating activities in 2007 was $38.7 million.

 

Net cash used in investing activities in 2007 was $500,000. This amount relates to the purchase of $43.4 million in marketable securities in 2007 with a maturity greater than 90 days, offset by the sale of $43.9 million in marketable securities with a maturity greater than 90 days.

 

Net cash used by financing activities in 2006 was $36.1 million, which consisted entirely of dividend payments made in 2007.

 

We collect our Basic Hire monthly in advance and pay our ship management fees monthly in advance. We receive Additional Hire payable quarterly in arrears. We expect charter revenues will be sufficient to cover our ship management fees, interest payments, administrative expenses and other costs and to continue to pay quarterly dividends as described below in under the caption Dividend Policy.

 

We believe that our cash flow from our Charters will be sufficient to fund our interest payments under our secured credit facility and our working capital requirements for the next one to three years. To the extent we pursue additional vessel acquisitions, we will need to obtain additional debt or equity capital. Our longer term liquidity requirements include repayment of the principal balance of our secured credit facility in January 2011. We anticipate requiring new borrowings, issuances of equity, or funds from a combination of these sources to meet this repayment obligation.

 

Dividend Policy

 

We have paid quarterly cash dividends on our common shares since our initial public offering in November 2004 in amounts substantially equal to the charterhire received by us under the Charters, less cash expenses and any cash reserves established by our Board of Directors. We have generally declared these dividends in January, April, July and October of each year and made payments in the subsequent month. Distributions to shareholders are applied first to retained earnings. When retained earnings are not sufficient, distributions are applied to additional paid-in capital.

There are restrictions that limit our ability to declare dividends, including those established under Bermuda law and under our existing secured term loan agreement. The terms of any future indebtedness we may enter into, including indebtedness that refinances our existing secured credit facility, may have stricter restrictions on our ability to pay dividends. Furthermore, higher interest rates or different repayment terms of future indebtedness, such as principal amortization requirements, may reduce the amount of cash that we would have available to pay future dividends. In addition to the discussion below, please see “Item 1A. Risk Factors — We cannot assure you that we will pay any dividends,” “— If we cannot refinance our secured credit facility, or in the event of a default under the facility, we may have to sell our Vessels, which may leave no additional funds for distributions to shareholders” “— We may not be able to re-charter our Vessels profitably after they expire, unless they are extended at the option of the Charterers.”

 

Under Bermuda law a company may not declare or pay dividends if there are reasonable grounds for believing either that the company is, or would after the payment be, unable to pay its liabilities as they become due, or that the realizable value of its assets would thereby be less than the sum of its liabilities and its issued share capital, which is the par value of our shares and share premium accounts, which is the amount of consideration paid for the subscription of shares in excess of the par value of those shares. As a result, in future years, if the realizable value of our assets decreases, our ability to pay dividends may require our shareholders to approve resolutions reducing our share premium account by transferring an amount to our contributed surplus account.

 

The declaration and payment of any dividends must be approved by our Board of Directors. Under the terms of our credit facility, we may not declare or pay any dividends if we are in default under the credit facility.

 

There can be no assurance that we will not have other cash expenses, including extraordinary expenses, which could include the costs of claims and related litigation expenses. There can be no assurance that we will not have additional expenses or liabilities, that the amounts currently anticipated for the items set forth above will not increase, that we will not have to fund any required capital expenditures for our Vessels or that our Board of Directors will not determine to establish cash reserves. The vessel operating expenses payable under our ship management agreements are fixed over the periods specified in those agreements. However, our cash administrative expenses, primarily related to salaries and benefits, travel and entertainment expenses, office costs, general insurance and other administrative costs, are not fixed, and may increase or decrease each year based on the factors described above in this paragraph.

 

The table below sets forth amounts that would be available to us for the payment of dividends for each of the fiscal years set forth below assuming that:

 

 

 

The table below does not reflect non-cash charges that we will incur, primarily depreciation on our Vessels. The timing and amount of dividend payments will be determined by our Board of Directors and will depend on our cash earnings, financial condition, cash requirements and availability and the provisions of Bermuda law affecting the payment of dividends and other factors. The table below does not take into account any expenses we will incur if the subsidiaries of Concordia and Stena and the two companies owned by Stena and Fram exercise their rights to have us register their shares under the registration rights agreement. For an overview of the registration rights agreement, see “Item 3. — Quantitative and Qualitative Disclosures about Market Risk— If a significant number of our common shares are sold in the market, the market price of our common shares could significantly decline, even if our business is doing well.”

 

We cannot assure you that our dividends will in fact be equal to the amounts set forth below. The amount of future dividends set forth in the table below represents only an estimate of future dividends based on the list of assumptions set forth above. The amount of future dividends, if any, could be affected by various factors, including the loss of a Vessel, required capital expenditures, cash reserves established by our Board of Directors, increased or unanticipated expenses, a change in our dividend policy, increased borrowings, more restrictive debt covenants, higher interest rates, principal amortization requirements or future issuances of securities, many of which will be beyond our control. As a result, the amount of dividends actually paid may vary from the amounts currently estimated and such variations may be material. There can be no assurance that any dividends will be paid. See “Item 1A. — Risk Factors — We cannot assure you that we will pay any dividends,” “— If we cannot refinance our secured credit facility, or in the event of a default under the facility, we may have to sell our Vessels, which may leave no additional funds for distributions to shareholders” and “— We may not be able to re-charter our Vessels profitably after they expire, unless they are extended at the option of the Charterers.”

 

The following table sets forth:

 

 

 

 

Our Secured Credit Facility

 

The following summary of the material terms of our credit facility does not purport to be complete and is subject to, and qualified in its entirety by reference to, all the provisions of our Term Loan Agreement. For more complete information, you should read the entire Secured Loan Facility Agreement incorporated by reference as an exhibit to this Annual Report on Form 10-K.

 

On December 12, 2005, we entered into a five-year term loan agreement with The Royal Bank of Scotland plc. The term loan agreement provides for a credit facility of up to $229,500,000. The purpose of the term loan agreement was to (1) refinance our existing indebtedness under our prior debt facility with a group of banks for which Fortis Bank (Nederland) N.V. acted as agent, (2) finance the purchase price of two Additional Vessels from Stena and (3) general corporate purposes. We completed the refinancing of our existing indebtedness of $135 million in December 2005 and completed the Additional Vessel acquisition in January 2006. The term loan agreement matures on January 5, 2011. All amounts outstanding under the term loan agreement must be repaid on that maturity date. There is no principal amortization prior to maturity. Borrowings under the term loan agreement bear interest at LIBOR plus a margin of 75 basis points. The margin would increase to 85 basis points if the ratio of the value of our Vessels to the amount outstanding under the loan facility falls below 2.0. The increased interest margin is equivalent to approximately $229,500 per year in increased interest costs in the event the ratio falls below 2.0. In connection with the term loan agreement, we have entered into an interest rate swap agreement with the Royal Bank of Scotland. As a result of this swap, we effectively fixed the interest rate on the term loan agreement at 5.7325%. The annual cash interest costs will approximate 5.38% due to the benefit that we received from the termination of our interest rate swap with Fortis Bank of $4.8 million that has been designated by the Board of Directors to offset the higher interest costs of the $229.5 million credit facility.

 

The term loan agreement contains restrictive covenants that prohibit us and our Vessel owning subsidiaries from, among other things: permitting certain liens on assets; selling or otherwise disposing of the our Vessels or selling other assets other than in arm’s-length transactions; acquiring assets outside the ordinary course of the our business, other than vessels; merging, amalgamating or entering into similar agreements with other entities; entering into certain types of vessel charters, including time charters or consecutive voyage charters of greater than 13 months (other than the Initial Vessel Charters and the Additional Vessel Charters); de-activating any Vessel; and paying dividends in certain circumstances.

 

The term loan agreement also contains financial covenants requiring that at the end of each financial quarter (1) our total assets (adjusted to give effect to the market value of the Vessels) less total liabilities is equal to or greater than 30% of such total assets and (2) We have positive working capital. In addition, the Loan Agreement contains covenants with respect to providing financial information to the lenders and the maintenance of insurance on our Vessels.

 

Events of default under the term loan agreement include, among others, cross defaults to other indebtedness in excess of $1 million, certain change of control of Arlington or our Vessel owning subsidiaries and certain payment breaches under the Charters. The term loan agreement provides that upon the occurrence of an event of default, the lenders may require that all amounts outstanding be repaid immediately and terminate our ability to borrow under the term loan agreement and foreclose on the mortgages over the Vessels and the related collateral.

 

We anticipate that we will seek to refinance our secured credit facility at or prior to its maturity. There can be no assurance that we will be able to do so on acceptable terms. Interest rates may be higher than current rates at the time we seek to refinance our secured credit facility and the prevailing market terms for loans such as the type we would need to refinance our secured credit may require periodic payments to amortize the outstanding principal. Such higher rates, principal amortization requirements or other terms could prevent our ability to complete a refinancing or could adversely impact our future results, including the amount of cash available for future dividends. Please see “Item 1A. Risk Factors — We cannot assure you that we will pay any dividends,” “— If we cannot refinance our secured credit facility, or in the event of a default under the facility, we may have to sell our Vessels, which may leave no additional funds for distributions to shareholders” and “— We may not be able to recharter our Vessels profitably after they expire, unless they are extended at the option of the Charterers.”

Long Term Financial Obligations and Other Commercial Obligations

 

Our long term financial obligations and other commercial obligations as of December 31, 2007 are as follows:

 

 

 

 

 

ITEM 15.   EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)(3) List of Exhibits.

 

The list of Exhibits filed as a part of this annual report on Form 10-K are set forth on the Exhibit Index immediately preceding such Exhibits, and is incorporated herein by this reference.

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on October 10, 2008.

 

ARLINGTON TANKERS LTD.

 

Name:     Edward Terino

Chief Financial Officer

 

 

 

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